Docket: PNC, IRS in Rematch Over Loan Accounting

PNC Bank Corp. returns to court this fall to appeal a June 1998 tax court ruling requiring banks to amortize origination costs over the life of loan.

The Pittsburgh-based banking company sued the Internal Revenue Service in 1996, arguing that loan origination costs should be deducted from income in the year they are incurred.

But the IRS differentiates loan origination costs from other expenses, arguing they create capital. Tax laws require capital costs to be amortized.

The IRS claims that two banks PNC bought owe $147,406 in back taxes because they did not spread deductions for origination costs over the life of the loans.

PNC counters that its everyday business of making loans is not a matter of creating capital.

The bank claims that these costs are ordinary and necessary, and therefore deductible in the same year they are incurred.

The specific costs in question are salaries, credit reports, property appraisals, and record keeping. PNC argues that those expenses are no different from other overhead costs, which do not create capital.

"There is no meaningful distinction between these costs, which are incurred in carrying on the banking business, and a myriad of other daily expenses, including rent, computer costs, and supplies," according to the bank's appeal brief.

A June 1998 U.S. Tax Court decision sided with the IRS, ruling that loan origination costs may not be deducted each year along with most other business expenses.

PNC is appealing the decision, and arguments could be heard as soon as September in U.S. Court of Appeals for the Third Circuit in Philadelphia.

In a separate case involving the parent of Fidelity Investors, the IRS is arguing that mutual fund start-up costs should also be amortized.

On the same day PNC lost, the Tax Court ruled against FMR Corp. of Boston. According to Fidelity spokesman, the company is in settlement talks with the agency.

How PNC's case is resolved could affect the tax bills paid by all lenders.

"Although loans are assets, we don't think they should be treated as capital assets, because this is what we do for a living," said Mark R. Baran, senior tax counsel of the American Bankers Association.

"It would have wide-ranging implications if it's held up on appeal."

While the case is being watched by "every bank in America," the issue affects other sectors, according to Ronald W. Blasi, a federal tax and banking law professor at Georgia State University.

The IRS "is pursuing an aggressive policy of challenging the current deductibility of a variety of business expenses," he wrote in a friend-of- the-court brief. Shifting money from one source to another-lending-is not the creation of an asset, Mr. Blasi argued.

The National Association of Manufacturers also weighed in, arguing that the tax court ruling could affect manufacturing companies that do consumer finance.

The definition of capital should not be applied "to encompass all costs that yield multiyear benefits," the group said.

If the government wins the PNC case, the IRS could instruct its agents to require lenders to deduct origination costs over the life of loans, Mr. Blasi said.

Currently, the agency's position is not consistently enforced, because there is no formal guidance in this area for agents conducting audits.

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